The Economic Problem

The economic problem is that only a limited amount of resouces are available to produce the unlimited quantity of goods and services people desire.

• resources are scarce
• incomes are limited
• choices have to be made

• what to produce
• how to produce it
• for whom to produce it
  

A production possibility diagram shows different possible combinations of goods that can be produced using available resources.

• producing within the curve is inefficient
• producing outside of the curve is impossible in the short run
• producing on the curve means all resources are allocated - efficiency

Opportunity cost is the cost of the next best alternative sacrificed.

• any course of action has an opportunity cost
• making more of good X means you have to make less of good Y
  

A consumer good, such as food or an iPod, is used by consumers to meet their needs and wants.

• iPods, TVs - consumer durable goods
• food, washing powder - non-durable consumer goods
• purchasing consumer goods (by households) is consumption

A capital good, such as a machine, is used to produce other goods, including consumer goods. 

• purchasing capital goods (by firms) is investment
  

Producuction is a process, or set of processes, that converts inputs into outputs.

• the eventual outputs are goods and services
• these make up our standard of living
  

Factors of production are inputs into the production process such as land, labour, capital and enterprise.

• enterprise is different to the others
• the entrepreneur decides how much of the other factors to employ
• the costs of employing these are the costs of production
• the entrepreneur is a financial risk taker and decision maker
• profit is the financial reward for this risk taking
• profit = revenue - costs
  

The most widely used method fo defining and classifying economic systems is according to the type of allocative mechanism which allocates resources.

Command economy is where the planning mechanism allocates resources between competing uses.

• a system where government officals allocate respurces to firms
  

Market economy is where markets and prices allocate resources between competing uses.

• a system of buying goods and services through the price mechanism in markets